Wednesday, March 19, 2008

Gold Plunges, Leads Commodity Slump on Outlook for Fed, Dollar

By Pham-Duy Nguyen and Millie Munshi

March 19 (Bloomberg) -- Gold plunged the most since June 2006, leading a decline in commodity prices, on speculation the slump in the dollar will end as the Federal Reserve eases the pace of interest-rate reductions.

The UBS Bloomberg Constant Maturity Commodity Index fell 61.3866, or 4.1 percent, to 1,428.009 at 5 p.m. in New York, led by declines in soybeans, wheat, cocoa and crude oil. The index of 26 commodities has dropped in three of the past four sessions and is down 9.3 percent from a record on Feb. 29.

The Fed yesterday cut the overnight-lending rate 75 basis points to 2.25 percent, the sixth reduction since September, in a bid to avert a U.S. recession. Analysts had forecast a bigger cut to 2 percent, an expectation that helped spur commodities to record highs as investors sought a hedge against inflation by stocking up on raw materials.

``This is a knee-jerk reaction to the fact that the Fed only lowered by 75 basis points,'' said Michael Pento, a senior market strategist at Delta Global Advisors Inc. in Huntington Beach, California, which manages about $1.5 billion. ``That's not what people were looking for.''

The U.S. Dollar Index, down 5.9 percent this year, rose 0.8 percent, the biggest gain in almost six weeks. Before today, the index had dropped on the prospect of lower borrowing costs.

Inflation concerns had boosted demand for raw materials, sending the UBS Bloomberg index up 17 percent this year before today. That compares with a 9.4 percent decline for the Standard & Poor's 500 Index.

Dollar-Fueled Gains

The declining dollar had boosted demand for commodities, which become cheaper for buyers holding other currencies. Investors also purchased raw materials to act as a store of value, Pento of Delta Global said.

The yen and franc also rose against major currencies on speculation investors were exiting carry-trade purchases of commodities that were financed with cheap loans from Japan and Switzerland.

``It's so much about leverage,'' said John McCarthy, director of currency trading at ING Financial Markets LLC in New York. Traders ``shorted the yen and franc to buy commodities.'' A short position is a bet a currency will decline.

``People have been forced to liquidate a lot of protection trades,'' said Hans-Guenter Redeker, global head of currency strategy in London at BNP Paribas SA, France's largest bank, in an interview today on Bloomberg Radio. Fed policy makers ``changed their tone,'' saying ``they are addressing inflation risk,'' which set off the drop in commodities, he said.

Destroyed Trends

``We did see a lot of trends that had been in place over the past six to seven weeks being destroyed today,'' Redeker said.

Gold for April delivery fell $59, or 5.9 percent, to $945.30 an ounce on the Comex division of the New York Mercantile Exchange, the biggest drop for a most-active contract since June 2006. Gold reached a record $1,033.90 on March 17.

In 1980, the price tumbled $50 a day from Jan. 22 to Jan. 24. On Jan. 21 that year, the metal climbed to $873, a record that lasted for almost 28 years.

Crude oil for April delivery fell $4.94, or 4.5 percent, to $104.48 a barrel on the New York Mercantile Exchange after a report today showed U.S. demand dropped. That's the biggest decline since Aug.6.

Unattractive Risk-Reward

``The Fed keeps coming in to alleviate concern,'' said William O'Neill, a partner at Logic Advisors in Upper Saddle River, New Jersey. ``The dynamics aren't there to push commodities higher at this point. Some investors have had huge profits in oil, platinum and gold. At this point, the risk- reward gets a bit unattractive.''

While the Fed said yesterday it expects a ``leveling-out'' of commodity prices, some investors are betting inflation will accelerate because of lower borrowing costs.

``Inflation will go through the roof,'' said investor Jim Rogers, who predicted the start of the commodities rally in 1999. Higher inflation will mean ``commodities will go through the roof,'' Rogers said today in an interview on Bloomberg Television.

On March 17, commodities dropped by the most ever recorded. The UBS Bloomberg gauge fell 4.6 percent, the largest decline since Oct. 3, 1997, when the data starts. The Reuters/Jefferies CRB Index plunged the most since at least 1956.

``The commodity bubble is bursting,'' said Phil Flynn, a senior trader at Alaron Trading Corp. in Chicago. ``There's a sense that the Fed created this bubble, and by cutting rates less than forecast they are deflating it.''